The Brisbane Manufacturing Company produces a single model of a CD player. Each

Question

The Brisbane Manufacturing Company produces a single model of a CD player. Each player is sold for $185 with a resulting contribution margin of $78.

Brisbane's management is considering a change in its quality control system. Currently, Brisbane spends $41,000 a year to inspect the CD players. An average of 2,100 units turn out to be defective - 1,470 of them are detected in the inspection process and are repaired for $75. If a defective CD player is not identified in the inspection process, the customer who receives it is given a full refund of the purchase price.

The proposed quality control system involves the purchase of an x-ray machine for $180,000. The machine would last for five years and would have salvage value at that time of $18,000. Brisbane would also spend $580,000 immediately to train workers to better detect and repair defective units. Annual inspection costs would increase by $25,000. This new control system would reduce the number of defective units to 370 per year. 320 of these defective units would be detected and repaired at a cost of $44 per unit. Customers who still received defective players would be given a refund equal to one-and-a-fourth times the purchase price.

Questions 1 & 2
1. What is the Year 2 cash flow if Brisbane keeps using its current system?  

2. What is the Year 2 cash flow if Brisbane replaces its current system?

Questions 3 & 4
3. Assuming a discount rate of 6%, what is the net present value if Brisbane keeps using its current system?  

4. Assuming a discount rate of 6%, what is the net present value if Brisbane replaces its current system?

*This is all the information that was provided to me*

Explanation / Answer

1. Year 2 cash flow under current system:

2. cash flow in year 2 if system is replaced:

3. NPV of current system:

System will have a perpetual cost of 267800, present value will be= 267800/6%= 4463333

4. NPV if system is replaced:

Equated annual cost of option= 920909.62 / 4.2123 = 218620.62 per year

Converting it into perpetuity= 218620.62/ 6%= 3643677

Quality control cost 41000 Repair of 1470 units@75 110250 Refund of 630 units @185 116550 Total cash flow 267800

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